Graphics by Nina Tagliabue
The BRB Bottomline: ESG investing is making its way into the mainstream. As investors and fund managers increasingly incorporate it into their portfolio, what should people know about it? This article explains the concept, debunks the myths surrounding ESG investing, and suggests points of improvement.
There has long been interest in responsible investing. In 1985, students at Columbia University protested because the university invested in several companies that had businesses in apartheid South Africa. Through months of action, the university eventually divested from its holdings.
In March 2020, Blackrock, the world’s largest asset management firm and largest investor in coal plant developers, launched the Global Impact Fund. The fund stands out in Blackrock’s offering because of two reasons: it focuses on companies in developing economies, and it invests in companies that meet the United Nations Sustainable Development Goals. Its inception is intended to erase Blackrock’s image of extensive investment in oil, gas and deforestation-reliant industries. At the same time, it reflects a growing interest in environmental, social and governance (ESG) investing—looking for companies that aim to do good in the society they operate in. By launching the fund, it represents a strong commitment in allowing investors to take part in the movement.
Choosing Companies to Invest In
Investors increasingly look beyond just solid business fundamentals before investing. Does a firm dispose of its waste properly or use environmentally friendly packaging? How fairly are workers paid and treated? Does a company have a culture of inclusiveness and ethical business practices? These questions exemplify the considerations investors have before investing.
I sat down with Geoff Woolley, a partner at Patamar Capital, a venture capital focusing on growing start-ups in Asia.
“The marginalized always get the worst products, at the highest prices, with little service or respect.” In Geoff’s perspective, a company has promise if it either improves product quality, customer service or pricing.
One of the companies Woolley talked about was Mapan, which partners with small family owned stores in Indonesia. Many of these store owners are exploited by multiple suppliers and middlemen who mark-up prices as products change hands. In recent years, many of these stores drove costs down and became competitive as Mapan streamlined the product distribution process for business owners.
This business model fueled Mapan’s growth. In 2019, Patamar Capital successfully exited its stake in the firm. In turn, Mapan was acquired by Go-Jek, Indonesia’s largest ride-hailing platform, as part of its venture into logistics.
Mapan’s success is attributable to its ESG goals. It saw a need in the market, and fulfilled them by creating a culture of driving change in society and aligning its entire mission around it. This translates into its rapid growth. Proponents of ESG investing argue that this approach drives a business’s success.
Retail Investor Demand
While venture capitals and private equity firms require extreme amounts of capital, conventional funds are allowing your average retail investor to take part with significantly less money.
Just how much are investors turning to ESG investing? According to Deloitte, the amount of money invested in ESG-mandated assets in the United States was US$3.7 trillion in 2012, comprising 11% of professionally managed assets. In 2025, total ESG-mandated assets are predicted to jump to US$34.5 trillion, comprising 50% of professionally managed assets.
Clearly, the share of ESG-focused assets is expected to grow rapidly, this indicates a strong interest in these types of investment assets. Investors allocate uninvested funds into ESG-focused assets, or switch from “normal” funds in favor of ESG funds.
And investment firms are responding to the increased demand. Between 2020 and 2023, fund managers are expected to launch 200 ESG-oriented funds, more than doubling the selection of investment options for investors.
In a response to the shift towards ESG investing, an increasing number of companies willingly publish their own annual ESG reports, helping investors make better decisions.
Returns vs Impact: Debunking the Myth
There is a common perception that ESG investing often leads to inferior returns. The reasoning is that as firms concentrate on improving working conditions for employees and improving business practices, they tend to forgo profits and returns on investment.
However, an analysis by Morningstar revealed that out of 745 ESG funds, most tend to consistently outperform their non-ESG counterparts, as well as the S&P 500, a popular market index.
Why is it that ESG funds perform so well? One consideration is that they do not contain energy equities, one of the biggest laggards in the market. By shifting away from unsustainable business practices, firms are able to project sustainable growth and drive up their share price organically.
Why Invest in ESG Firms?
In a paper written by UC Davis and UC Berkeley economists, people are willing to hold on to firms that are willing to pay more for socially responsible funds, even when the fund underperforms.
Because investors cannot see the impact their investments have firsthand, a common alternative is to look for a non-ESG equity that outperforms in the stock market, compare it to a financial instrument that scores well in ESG metrics, then donate the difference and retain some of the returns.
This method provides a more tangible way for investors to see results first-hand. However, it misses out on the spirit of ESG investing. Shareholders are the main entities keeping firms accountable: they provide much needed capital for firms to improve a product and expand. In exchange, investors have the ability to vote for decisions in shareholder meetings, or sell their stake in protest of unethical practices.
Therefore, deliberately investing in firms that perform poorly in ESG metrics encourage the growth and continuation of poor business practices, while leaving sustainable firms scrambling for much-needed capital.
Accounting and Auditing: Points of Improvement
Many have stated that impact investing would serve the community better if the impact investors are investing in companies that have clear, quantifiable metrics that can measure how much impact they can deliver. While 86% of S&P 500 companies publish some form of ESG report, many metrics are not standardized. In addition, many companies self-report their ESG results, it creates the potential for manipulation and false reporting.
To standardize and improve the reliability of reports, ESG can borrow from two industries: accounting and auditing. In accounting, the GAAP (generally accepted accounting principles) standardizes financial statements, and all publicly traded companies have their financial statements audited. A universal set of standards and a second party to verify reports can help keep companies accountable and make comparisons easier.
Take-Home Points
ESG investing helps drive ethical business decisions and accomplish more than just fill wallets. As ESG investing shifts from a niche form of investing and enters the mainstream, it is important to clear up misunderstandings about the practice. Returns from ESG are favorable as long-term investing drives sustainable decisions. However, many of the frameworks used to evaluate ESG are inadequate. As more investors look more toward this form of investment, the standards that provide information should change, too.
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